special purpose entity enron

The reduction of credit risk and the marketability of the SPE equity generally diminishes the cost of the capital to a level below that the sponsor would have achieved on its own. Again, it should be noted that such credit enhancement features typically should not be extended to the 3% (now 10%) equity investor as this investment must be ‘at risk’ in order for the SPE to be eligible for deconsolidation by the transferor. The prior example is one of the many types of transactions that use an SPE. The form of the SPE and the structure of the transaction can be vastly different for SPEs used in off-balance sheet activities and leasing arrangements. Reflections of SPE History by Dennis Beresford Bob, I’m not really an expert in this area but I’ll share some of my limited knowledge. The 3% (now 10%) rule came about as a result of EITF deliberations a few years ago regarding special purpose leasing entities.

special purpose entity enron

Among these three venues, there are other considerations that may affect the final choice, however. The Netherlands seems to take several weeks longer to provide tax rulings for SPEs compared to Ireland and Luxembourg. In the Netherlands, there seems to be a turf war between Amsterdam versus Rotterdam, and most SPEs are set up in Amsterdam. In Ireland, the SPE must fit within the Irish tax securitization code. Based deal arrangers might find it more convenient to deal with Ireland, since Ireland uses an English law based system. Lately, Ireland has been the fastest of the three venues in actual set-up time; usually two to three weeks once the paperwork is in order.

The Most Typical Holding In A Special Purpose Vehicle

They stated they feared “misperception” of the reason for the choice of a synthetic lease. For securitization of cash assets, the key focus is on non-recourse (non-recourse to the originator/seller) financing. The structures are bankruptcy remote so that the possible bankruptcy or insolvency of an originator does not affect the investors’ right to the cash flows of the vehicle’s assets.

Dorgan also said the committee will invite Skilling, Enron’s former chief executive, and Andrew Fastow, Enron’s former chief financial officer, to testify at the same hearing. He might bestow upon them more than they’d hoped for when he took command of the USS SEC. But his commission will be short lived. The powerful Chairman of the House Energy and Commerce Committee, John Dingell (D-Mich.), will have this peach diced and sliced and then toss the Pitt on the floor of Heartbreak Hotel. Former Captain Harvey Pitt will be so maligned in the media that he will be blacklisted and possibly disbarred. “I think we had lots of smoking guns,” says former chairman Arthur Levitt.

However, before sentencing was scheduled, Lay died on July 5, 2006. At the time of his death, the SEC had been seeking more than $90 million from Lay in addition to civil fines. She sold roughly 500,000 shares of Enron ten minutes to thirty minutes before the information that Enron was collapsing went public on November 28, 2001. Sources claimed that Enron was planning to explain its business practices more fully within the coming days, as a confidence-building gesture. Enron’s stock was now trading at around $7, and by this time it was obvious that Enron could not stay independent. However, investors worried that the company would not be able to find a buyer.

When Enron wanted to engage in a second JEDI deal with CalPERS in 1998, they discovered that CalPERS wanted out of the first JEDI deal before they would invest in the second. CalPERS $250 million stake in JEDI 1 was then valued at $383 million. It is best to think of the Chewco deal as two separate transactions, one for temporary financing of the purchase of CalPERS’ stake and the other permanent financing .

Enron Aside, Special Purpose Vehicles Spvs Are Legal, Innovative And Widely Used

Billions of pounds have been wiped off the value of people’s savings, pensions and investments. The dates of the closing of the deal and the IPOs aren’t tied to each other. The AIG-New York Fed transaction is expected to close late in the third quarter of this year. AIA, which has already launched its IPO process, is expected to start the offering in 2010. While ALICO hasn’t started the process of its offering just yet, it has announced its attention to do so. These projects were initiated at the request of investors, the SEC, and The President’s Working Group on Financial Markets. Copies of the new standards are available at theFASB’s website,along with a concisebriefing document.

special purpose entity enron

These transactions are often referred to as synthetic leases and provide tax-advantaged financing lower than traditional mortgage loans. Another form of tax-advantaged SPE transaction is the sale to an SPE of an asset that qualifies as a financing under tax regulations, with any gain on sale deferred for tax purposes.

Founders typically retain voting control even if their share holdings are reduced to a minority position. The two class of shares approach to retaining control by founders is common in technology offerings, most famously in Facebook. Two classes of stock are not allowed on the Hong Kong exchange, and that presents a challenge for U.S. listed companies that may want to move onto the Hong Kong exchange if they get kicked out of the U.S., but that is another story. Did an independent third party make a substantive (3%) capital investment in the SPE? It is difficult to understand how a partnership controlled by Enron’s executive vice president and CFO could be construed as an independent third party.

Without being able to analyze each individual contract and the assumptions made, it is not possible to render a professional judgement here, but it is an area that gives management wide latitude to distort the economic value of contracts. Turning now to Enron’s accounting methods, Enron used mark-to-model (not just mark-to-market) in accounting for a wide range of commodity and derivatives contracts. For contracts that lack a readily available market price, Mark-to-market accounting allowed the company to estimate the present value of each contract by projecting both future costs and benefits, which of course are uncertain at the time the contract is entered. In essence, Enron booked profits at the date the contract began, regardless of how these contracts ultimately performed in the future. Of course, for illiquid assets, marking to model is necessary, but in such cases, there needs to be an aggressive discount for the uncertainty of what market prices and costs will be realized over the life of the contract, not to mention the constraints from poor liquidity. As far as LJM1 is concerned, it received 3.4mm shares (pre-split) of ENE stock at initiation valued at $168mm (including the 39% discount), but forwarded only 1.6mm shares to SWAP SUB .

All of these shares had a current face value of approximately $537 million. In ex-change for these shares and options, Enron received net notes from Talon worth $350 million. See Exhibit 1 for a hypothetical reconstruction of Enron’s journal entries for this arrangement. (So don’t bother trying to call it — no one will answer!) To establish this trust, the company must sell the SPE an asset — any of the ones listed on its balance sheet will do. In this case, it sells its receivable balance and therefore must remove it from the balance sheet. The SPE pays the company for the receivables with the money it collects from these new investors and the company gets to beef up the cash section of its balance sheet.

Time Com

Although the FASB’s Director of Research and Technical Activities is the non-voting Chairman of the EITF, there is no overlap between the members of the FASB and the EITF. Note that the influence of the public accounting sector of the accounting profession is much greater on the EITF than it is on the FASB (three of seven full-time members were public accounting practitioners prior to joining the Board). One might contra asset account conclude that authoritative guidance provided by the EITF is likely to have more of a public accounting tilt than if it is provided by the FASB. This is an important and instructive outcome, showing how the FASB allows comment to come up with logical counterarguments to its tentative guidance, which tends to narrow and loosen the wide and tight nets it casts in response to calls to improve financial reporting.

Chiron Corp., another biotech company, is proceeding with financing a more than $200 million expansion of its Emeryville, Calif., headquarters, although the deal isn’t yet completed, says John Gallagher, a company spokesman. Idec Pharmaceuticals Chief Financial Officer Phillip Schneider says that while accountants and lawyers at the San Diego-based biotech company have become “less comfortable” with synthetic leases, “we’re still looking at that as an option.” 3.) What is meant by DuGan when he said, “but synthetic leases have a hidden balloon payment.”?

In Enron’s case there is no cash coming in from outside plus Fastow and company do not have capital to underwrite the risk. Enron is putting the assets their own stock [it would not have mattered if it was some other company’s stock or Enron’s cash! All Fastow is doing is giving Enron the wiggling room in accounting to get liabilities off balance sheet at a price. When no risk is transferred why is Enron getting into this deal is the question auditors should be asking rather than all the GAAP rules! FASB Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, states that financial reporting should provide information that is useful in making business and economic decisions.

  • At the time of his death, the SEC had been seeking more than $90 million from Lay in addition to civil fines.
  • As of Q4 2009, financial services companies in the S&P 500 had stashed $5.5 trillion, and $1.6 trillion, respectively, in variable-interest entities and the now-defunct qualified special-purporse entities .
  • The servicer in structured transactions is often the originator of the assets in question.
  • The SPE would pay for such losses out of the value of the restricted Enron stock it received.

The assets to be repurchased or redeemed the same or substantially the same as those transferred.? Paragraph 48 describes six characteristics that must all exist in order for a transfer to meet the substantially-the-same requirement in paragraph 47. One of those characteristics is that the same aggregate unpaid principal amount or principal amounts within accepted ?

Also called special purpose vehicles, SPEs typically are defined as entities created for a limited purpose, with a limited life and limited activities, and designed to benefit a single company. They may take the legal form of a partnership, corporation, trust, or joint venture. A newly created SPE would acquire capital by issuing equity and debt securities, and use the proceeds to purchase receivables from the sponsoring company, which often guaranteed the debt issued by the SPE. Because the receivables have limited and reliably measured risk of nonrepayment, a relatively small amount of equity usually was sufficient to absorb all expected losses, thus making it unlikely that the sponsoring company would have to fulfill its guarantee. In this way the sponsoring company could convert receivables into cash while paying a lower rate of interest than the alternative of debt or factoring, as the debt holder could be repaid from the collection of the receivables or the sponsor. SPEs also allow the sponsors to remove receivables from their balance sheets, and avoid recognizing debt incurred in the securitization. For example, an SPE might issue debt or equity, using the proceeds to acquire financial instruments from its sponsor.

Enrons Special Purpose Entities

Many feared other “mistakes” and restatements might yet be revealed. This ruse was used several times to fool analysts about the progress of different areas of Enron to help improve the stock price.

Tavakoli Structured Finance Llc

Porcupine cashed in a sufficient number of warrants to return $39.5 million in cash, the orally agreed-upon amount, to LJM2. Now able to engage in hedging activity with Enron, Porcupine sold a total return swap to Enron covering 18 million shares of New Power at $21 per share. This hedging contract would force Porcupine to compensate for any fluctuations in the value of Enron’s investment in New Power. Porcupine had insufficient reserves to support its hedge agreement with Enron, because it could cover contra asset account losses only from its own near-worthless investment in New Power. LJM2 contributed $30 million of equity to Talon, with the understanding that it would receive a return of $41 million on this investment before Enron/Harrier could proceed to trade derivatives with Talon. To fund future hedge transactions, Enron/Harrier issued to Talon approximately 3.7 million restricted shares of Enron stock, and rights to an additional 3.9 million shares to be issued under certain circumstances in future years.

What Went Wrong At Enron?

It suggests that their financial sophistication had to be at odds with their corporate strategy. With respect to the permanent financing of the CalPERS buyout deal, this is where you have to pay attention closely. Fastow engaged in an elaborate scheme to keep the SPE’s from being reported on Enron’s consolidated financial statements, partly by creating a daisy chain of SPE’s that could potentially comply with accounting criteria governing non-consolidation.

A Little More On What Is A Special Purpose Vehicle

But the future state of the companies’ balance sheets remains unclear, since they only consolidated 9% of the $5.7 trillion in off-balance sheet assets they reported in the fourth quarter of last year. About $4 trillion of the remaining assets will be taken up on the balance sheets of mortgage companies Fannie Mae and Freddie Mac, which guaranteed many of the subprime residential mortgages. The rest of the assets — about $1.2 trillion worth — could find their way to the balance sheets of companies that have yet to claim them, or “on no one’s balance sheet,” assert report authors David Zion, Amit Varshney, and Christopher Cornett. Under typical VIE online bookkeeping agreements, the founder agrees to transfer his VIE shares to another VIE shareholder at the public company’s request, and to otherwise vote those shares and select VIE management at the public company’s direction. Since the public company can remove the VIE owner at will, it has been thought that the VIE owner has no rights, and accordingly no interest in the VIE. Therefore the public company is the only beneficiary of the VIE and can consolidate it into their financial statements. As Enron increased its portfolio of equity investments, company managers found that mark-to-market losses were having an increasingly adverse effect on net income.

Even if the transfer qualifies as a sale, the provisions of IAS 27 and SIC-12 may mean that the enterprise should consolidate the SPE. SIC-12 does not address the circumstances in which sale treatment should apply for the reporting enterprise or the elimination of the consequences of such a sale upon consolidation. This Statement requires that servicing assets and liabilities be subsequently measured by amortization in proportion to and over the period of estimated net servicing income or loss and assessment for asset impairment or increased obligation based on their fair values. I understand the SEC will probably also tell companies that they need to enhance their MD&A disclosures about special purpose entities.

But SPEs also evolved into an effective scalpel for CFOs looking to perform cosmetic surgery on their balance sheets. That’s because the accounting rules say that as long as a company owns less than 50% of an SPE’s voting stock, the SPE’s assets and debt don’t have to be consolidated on its books. In fact, due to a particularly egregious accounting reg, the SPE’s nominal owner–usually some friendly outside investor–needs to put up only 3% (now 10%) special purpose entity enron of the SPE’s equity. The company establishing it can contribute the remaining 97%, and it still qualifies for off-balance-sheet treatment. Other transactions were implemented–improperly, we are informed by our accounting advisors–to offset losses. We believe these transactions resulted in Enron reporting earnings from the third quarter of 2000 through the third quarter of 2001 that were almost $1 billion higher than should have been reported.

In the the past, SPEs like Enron’s weren’t required to be consolidated on Enron’s balance sheet, simply because Enron would structure the SPE to avoid control, basically sidestepping the consolidation requirement. And that allowed Enron the opportunity to transfer risky assets, bad debts, and contractual liabilities over to the SPE and book the transactions as sales. Enron is best known for its use of Special Purpose Entities to manipulate accounting results. Enron would own most of a subsidiary corporation or partnership, but outsiders would have voting control, so that the entity would not be treated as part of Enron on its financial statements. Practice at the time was that outside investors put up at least 3% of the equity capital. In fact, in many of the Fastow/Enron deals, outsiders did not, and would not, put up 3% because the deals were so screwy. As illustrated in the below table, the three primary entities involved in the LJM1 hedging transaction were Enron as the sponsor, LJM1 as the senior SPE and Swap Sub as the subordinate SPE.

Another lesson, then, is that CPA firms should ascertain that their personnel are capable of dealing with the presently existing activities of their clients. By November 2000, Enron had entered into derivative contracts with the Raptors I, II, and III with a notional value of $1.5 billion on which it had a gain of $500 million. However, the Raptors’ principal asset from which it could pay this amount consisted of Enron stock or obligations, or TNPC stock. By late March 2001, as the price of Enron’s shares declined, the Raptors’ credit capacity also declined. To avoid having to report a $500 million pre-tax charge against earnings, Enron executed a cross-collateralization among the Raptors, “invested” additional Enron stock contracts, and engaged in a series of complex and questionable hedges and swaps with the Raptors.

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